Thursday, August 11 2022

Two recent U.S. district court decisions have rejected attempts to include nonconsensual third-party releases in chapter 11 reorganization plans. These rulings suggest that third-party releases may be facing increasing pushback for part of the courts.

Traditionally, bankruptcy only operates to eliminate the rights of creditors against the debtor. In recent years, however, corporate debtors have increasingly attempted to include non-consensual third-party releases in chapter 11 reorganization plans. These third-party releases, when approved by the bankruptcy court, operate to prevent debtor’s creditors exercise their claims against non-debtor third parties. Despite being increasingly found in chapter 11 restructurings, third-party releases have continued to be controversial and hotly debated, both inside and outside the courtroom.

These debates culminated in the United States District Court for the Southern District of New York. investment of the bankruptcy court’s order confirming a plan for Purdue Pharma, LP (“Purdue”), in which it held that the bankruptcy court had no legal authority to approve third-party exemptions from the plan. The court noted that Purdue, a pharmaceutical company with most of its revenue coming from the sale of the prescription opioid OxyContin, has faced a “veritable tsunami of litigation” arising from the marketing and sale of OxyContin. As a result, Purdue filed for bankruptcy in September 2019. After two years of extensive litigation and negotiations, Purdue obtained confirmation of a reorganization plan that, among other things, contained third-party releases that eliminated creditor claims from Purdue directly against your private property. owners (the Sackler family) and other non-debtor entities, including claims arising from alleged willful misconduct and fraud. In exchange, the Sacklers agreed to contribute approximately $4.5 billion to fund charities and certain recoveries under the plan. Although the plan was supported by an overwhelming majority of creditors, many states and other creditors objected and appealed the plan after it was confirmed.

On appeal, the Southern District of New York vacated the confirmation order. In a 142-page decision, the District Court held that nothing, either express or implied in the Bankruptcy Code, gave a bankruptcy court legal authority to confirm a plan that contained non-consensual third-party releases. Among other things, the District Court rejected the argument that Bankruptcy Code sections 105(a), 1123(a)(5), 1123(b)(6), and 1129(a)(1), either individually or together, allow approval of third-party releases, noting that neither section could, in context, be read to grant such a broad ability to release non-debtor claims against non-debtors. The District Court similarly reasoned that Congress’s enactment of Bankruptcy Code sections 524(g) and (h)—which allow third-party releases but only in asbestos cases—indicated that such releases were not permitted. in other cases.

In the second case, Patterson v. Mahwah Bergen Retail Group, Inc., the United States District Court for the Eastern District of Virginia left the door open for third-party release, but imposed significantly more stringent requirements for inclusion than the bankruptcy court had applied. This case involved the bankruptcy of a retail chain that sold clothing for women and girls. The debtor sold its assets and then submitted a plan containing extensive third party disclosures. The debtors gave the creditors the ability to opt out of the third-party release, but unless they opted out, the creditors were deemed to have agreed to the terms of the release. The bankruptcy court treated the third-party releases as consensual due to the existence of the opt-out and upheld the debtor’s plan.

On appeal, the District Court vacated the confirmation order. It held that the third-party releases in the plan were intended to extinguish an “extraordinarily wide range of claims” and that, before confirming a plan containing such releases, a bankruptcy court had to determine whether it had jurisdiction over those claims. ID. at *41. Here, the District Court held that only a “superficial review” was needed to determine that the third-party exemptions exceeded the constitutional authority of the bankruptcy court under Stern vs. Marshall, 564 US 462 (2011), because many of the released claims had no apparent connection to the debtor’s bankruptcy. Thus, even if the releases were constitutional, the court ruled that the bankruptcy court could not constitutionally order them. The District Court reconciled its decision with the recent decision of the Third Circuit in Regarding Millennium Lab Holdings II, LLC945 F.3d 126, 139 (3d Cir. 2019) upholding the constitutional authority of the bankruptcy court to impose third party release under duress under Sternnoting that in Millennium Lab Holdings II the third-party releases were determined to be an integral part of the debtor’s restructuring based on a large number of detailed factual findings. The same could not be said in this case.

The District Court also held that the bankruptcy court erred in inferring consent from the parties’ inaction by failing to affirmatively opt out of the exemptions. The District Court held that while nonconsensual third-party releases may be approved, where jurisdiction exists, they must satisfy the Fourth Circuit’s seven-factor test in Behrmann v. Nat’l Heritage Found., Inc., 663 F.3d 704 (4th Cir. 2011), and even then, they should be used “with caution and infrequently.” The seven-factor test adopted by the Fourth Circuit in behrmann (after the Sixth Circuit ruling in In relation to Dow Corning Corp., 280 F.2d 648 (6th Cir. 2002)), only allows non-consensual third-party releases when: (1) there is an identity of interest between the debtor and the third party such that a claim against the non-debtor would exhaust the assets of inheritance; (2) the nondebtor has contributed substantial assets to the reorganization; (3) the injunction is essential to the reorganization; (4) the affected class or classes voted overwhelmingly to accept the plan; (5) the plan provides a mechanism to pay all, or substantially all, of the claims of the class or classes affected by the injunction; (6) the plan provides an opportunity for claimants who choose not to settle to fully recover and; and (7) the bankruptcy court made a record of specific factual findings supporting its conclusions.

Both decisions, well worth reading in their entirety, demonstrate significant legal issues not fully discussed above, causing district courts to reject third-party releases in chapter 11 plans and indicating the tide may be turning. changing against him. Furthermore, as the Southern District of New York hinted at in the Purdue Pharma case but neither of these two courts decided, even if the Bankruptcy Code authorized non-consensual third-party releases, they remain subject to many potential constitutional challenges that have yet to be resolved. been litigated. However, only time (and subsequent decisions) will tell if the party is really over for non-consensual third-party releases.

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